3.4 Market structures ~ Perfect competition

What are the 6 key assumptions of a perfectly competitive market?

1. Many firms and buyers

2. Homogenous products

3. Perfect knowledge (for both firms + consumers)

4. No barriers to entry/exit

5. Price takers - take market price - where S=D

6. Objective is profit max 

Why is each firm a price taker in perfect competition?

Because they don't have the ability to influence the price of a product they produce

→ They must accept the market price for their product

Often because each firm is too small relative to the market to influence price

What does perfect knowledge mean in this context?

Buyers + sellers have full, instant access to all market info

Why are products described as homogenous in perfect comp?

Products are identical + perfectly substitutable

→ Consumers see no difference between suppliers

→ This makes demand for each firm’s output perfectly price elastic - if a firm raises its price, it loses all sales to competitors

What is meant by no barriers to entry/exit?

There are no significant legal, tech, cost barriers preventing new firms from entering if SNP exist

Also no barriers preventing firms from leaving if losses occur

→ This drives long-run equilibrium where only normal profit is made

How does the number of buyers + sellers affect market power?

Large number of buyers + sellers = each participant only supplies/demands a tiny fraction of the market 

→ No single firm/consumer can affect the price - they must accept market price equilibrium

Why are transport costs and barriers to entry assumed to be negligible?

Stops firms gaining local power or keeping abnormal profits — keeps competition perfect

→ If transport costs or entry barriers exist, a firm might gain local market power (control over its nearby market) and be able to keep earning abnormal profits instead of being forced down to normal profit by new competition.

Why does profit always return to normal profit in the long-run equilibrium?

New firms enter if profits are high and leave if losses happen, so price adjusts until firms earn just enough to stay in business - normal profit (no extra)